Working Paper: CEPR ID: DP3288
Authors: Bruno Biais; Larry Glosten; Chester S. Spatt
Abstract: We survey the literature analysing the price formation and trading process, and the consequences of market organization for price discovery and welfare. We develop a united perspective on theoretical, empirical and experimental approaches. We discuss the evidence on transaction costs and the price impact of trades and its analyses in terms of adverse selection, inventory costs and market power. We review the extent to which the associated frictions can be mitigated by such features of market design as the degree of transparency, the use of call auctions, the discreteness of the pricing grid and the regulation of competition between liquidity suppliers or exchanges.
Keywords: bid-ask spread; liquidity; market design; market microstructure; transactions costs
JEL Codes: D82; G10; G14; G20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| transaction costs (D23) | trading behavior (G41) |
| transaction costs (D23) | market efficiency (G14) |
| transaction costs (D23) | price formation (L11) |
| increased transaction costs (D23) | reduced liquidity (G33) |
| reduced liquidity (G33) | ability of traders to execute orders efficiently (G14) |
| market design features (D40) | transaction costs (D23) |
| strategic behavior among liquidity suppliers (D43) | market power (L11) |
| market power (L11) | relationship between trading activity and price outcomes (G19) |